PowerPoint: CHAPTER 2 – Business Cycles

A time series that shows what happens to the
value of the domestic output (GDP) of the
economy over time.
2 schools of thought:
Exogenous
Endogenous
•
•
•
•
Classical Economists – 19th century
market economies are inherently stable
Exogenous factors cause business cycle
William Jevons sunspot theory
– business cycle was caused by periodic changes in
solar radiation
Other exogenous variables
• changes in the money supply,
• government policies
• technology
– railways 19th century
– radio communication in the 1920
– Internet in the1990s
• John Maynard Keynes – Keynesian Theory
• inherently unstable - caused by endogenous e.g. change in
total spending.
• An increase in total spending
• period of expansion
• reinforced by the multiplier
• economy reaches its capacity (full employment)
• firms decrease their investment spending
• multiplier process goes into reverse
• output of the economy to decline
Followers of the endogenous theory believe that
gov. SHOULD intervene to minimise effects of
cycle.
• Answer Activity 1 - pg 49 Q 1.1 – 1.4
• Answer Activity 2 - pg 52 Q 1.1 – 1.3
SA’s economic system based on Keynesian view so
government intervenes.
They apply policies to affect business cycles to ensure
that:
• economic growth (increase in real GDP) is maintained
• inflation and unemployment are as low as possible
• periods of expansion last as long as possible
• periods of contraction last as short as possible
• the troughs and peaks are smoothed out (the economy
is more stable).
Instruments at the gov’s disposal are…
Fiscal policy: how the government’s budget is used to raise and
spend money to influence economic activity.
Contractionary Fiscal Policy
Economy
expanding
too quickly
increase
taxation
(leakage)
decrease
expenditure
(injection)
Consumption
& Gov
Spending fall
Opposite is true for an expansionary fiscal policy
Decreasing
AD slows
economy
Monetary policy: policy of central bank regarding
money supply and interest rates to influence
economic activity.
Supply of money influenced by…
• Interest rates
• Buying and selling of gov bonds
• Increase/decrease cash reserve requirements of
commercial banks
• SARB governor can persuade commercial banks
to lend less in booms and more in recessions.
Expansionary Monetary Policy
SARB
decreases
repo rate
-interest
rate
follows
More
money is
available
Spending
increases
Demand
increases
Supply
increases
Economic
activity
increases
Opposite is true for a contractionary monetary policy
New economic paradigm: government focuses
less on fine-tuning and more on eliminating
uncertainties with regard to fiscal and monetary
policy.
WHY???
Fine tuning requires precise knowledge at the
right time – not always possible.
Instead…
• Create ec stability
• Encourage high rates of ec growth without
inflation
• Combine demand and supply-side policies
Demand-side policies
Supply-side policies
Monetary policy
Providing infrastructure
Fiscal Policy
Decreasing red tape
Subsidies to firms
Decrease corporate tax
Improve quality and mobility of labour
force
Free business advisory services
Review competition policy
Answer Activity 3 – pg 56 Q 1.1 – 1.3
Leading indicators: change before the economy changes.
• Warn of what we can expect in the future - economists
use them to forecast.
• Reach peaks/troughs a few months before the
business cycle reaches
Examples
• volume of mining production
• total number of new cars sold
• share prices
• number of new businesses registered
Lagging indicators: change only after the economy has
changed.
• Indicate what has already happened in the economy.
• Confirm direction of the economy.
• Used to estimate whether individual indicators gave
false signals.
• Reach a peak/trough months after the business cycle
Examples…
• hours worked in construction
• Employment
• investment in capital goods
Coincident indicators: change at the same time as the
economy.
• Information about the current situation of the
economy.
• Move simultaneously with the economy.
• Reach peak/trough at the same time as the business
cycle
• Used to compile business cycle.
Examples …
• real GDP
• Unemployment
• volume of manufacturing
• production
Done using quantitative or qualitative scientific
methods
Quantitative method based on mathematical
models, statistics and historical time series data.
By using moving averages (purple line), we can smooth out
volatile data (blue line) and identify the trend more easily. This
allows for more accurate extrapolation of the trend (red line).
Answer Activity 4 – pg 60 Q 1 – 3